Flashnote Telecoms, Media & Technology Equity China Buy Target price (USD) 231.00 Share price (USD) 197.68 Upside/Downside (%) 16.9 Performance 1M 3M 12M Absolute (%) -2.8-10.3-12.7 Relative^ (%) -3.5-10.2-23.4 Index^ NASDAQ 100 INDEX RIC BIDU.OQ Bloomberg BIDU US Market cap (USDm) 54,521 Enterprise value (CNYm) 344142 Free float (%) 100 Chi Tsang*, CFA Head of Asia The Hongkong and Shanghai Banking Corporation Limited +852 2822 2590 chitsang@hsbc.com.hk Alice Cai* Associate Analyst The Hongkong and Shanghai Banking Corporation Limited +852 2996 6584 alice.y.cai@hsbc.com.hk View HSBC Global Research at: http://www.research.hsbc.com *Employed by a non-us affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations Issuer of The Hongkong and Shanghai report: Banking Corporation Limited Disclaimer & Disclosures This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it Baidu (BIDU US) Buy: Catch me if you can Soft results and guidance Stronger search margins to support doubling down on O2O Maintain Buy but lower our PEG-based TP to USD231 (from USD256); an HSBC Asia Super Ten portfolio stock Soft results and guidance. Total revenue grew 38% y-o-y to RMB16.6bn, in line with our estimates. Operating margins were 21%, 360bp lower than our estimate, due to higher-than-expected content costs and R&D. Non-GAAP EPS was USD1.81, 9% below our estimate. For 3Q, management expects revenue to grow 34% to 37% y-o-y, compared to our estimate of 38% and consensus of 39% growth. We point out that Baidu no longer sells keywords to its competitors in group-buying and other owned and operated O2O verticals, which is putting slight pressure on revenue growth. Further, while take rates for O2O range from single digits to double-digit %, promotional activities (couponing) are recognized as contra revenue, thus, capping any revenue contribution from O2O. Stronger-than-expected margins for search. For the first time, management revealed margins for its search business and the significant drag from O2O and others, as well as iqiyi. Specifically, operating margins in 2Q were 20.9%, and O2O and others represented a 25.3ppt drag on margins, while the iqiyi video business lowered margins by 5.1ppt. Thus, Baidu's core search business had 51% OPM. In addition, iqiyi generated RMB1bn in revenue in 2Q, up c80 % y-o-y. We estimate search revenue grew 35% y-o-y in 2Q. Baidu had 629m search MAUs (Monthly Active Users) and 304m map MAUs in June. Doubling down on O2O. Management estimates the O2O market in China is RMB10trn and its very strong initial success is giving it confidence to increase its investment aggressively. In particular, total GMV for O2O (Qunar, Nuomi group buying and food delivery) doubled y-o-y to RMB40bn. We estimate GMV was RMB3.5bn, excluding Qunar. Specifically, Nuomi's market share has doubled since January to c20% and accelerating since May. It is in 300 cities and is No.1 in 60 cities. Baidu s take-out delivery doubled its GMV q-o-q and its average delivery order size is 2x its nearest competitor, with food delivered in 45 minutes. The food delivery business raised USD250m in outside capital from a strategic investor last week. Management now expects to increase its SGA by 80-90% y-o-y in 2H for O2O, implying total SGA of RMB19bn this year, up 80% y-o-y, compared to the original guidance of 50% y-o-y (RMB15bn). Maintain Buy but lower our PEG-based TP to USD231 from USD256 to reflect lower forecasts in EPS, but partially offset by higher future CAGR. While we are surprised by the rapid step-up in spending, we believe strong share gains support this investment. Further, we believe that O2O is a natural extension for Baidu in China, leveraging its large base of mobile users who already use its best-in-class search and map technology to search for products and services, and the biggest sales force in the country. Although we point out that material O2O monetization (where couponing declines) is a few years away, Baidu's valuation remains compelling at 22x 2016e EPS. At current levels, Baidu's core search business is trading at 12x 2016e EPS, with c25% revenue growth. In addition, a spin-out of its iqiyi business could unlock value for shareholders.
Financials & valuation Financial statements Year to 12/2014a 12/2015e 12/2016e 12/2017e Profit & loss summary (CNYm) Revenue 49,052 67,043 87,314 110,802 EBITDA 16,755 15,758 20,540 27,987 Depreciation & amortisation -3,951-4,648-4,852-6,055 Operating profit/ebit 12,804 11,110 15,688 21,932 Net interest 1,364 2,003 4,216 7,274 PBT 14,475 13,507 20,215 29,518 HSBC PBT 14,475 13,507 20,215 29,518 Taxation -2,231-2,681-3,032-4,428 Net profit 13,187 12,218 18,383 26,291 HSBC net profit 13,187 12,218 18,383 26,291 Cash flow summary (CNYm) Cash flow from operations 17,937 20,654 32,183 47,582 Capex -4,827-4,209-8,731-9,972 Cash flow from investment -22,468-4,209-8,731-9,972 Dividends 0 0 0 0 Change in net debt 3,943-6,243-23,451-37,610 FCF equity 14,311 16,750 23,139 37,298 Balance sheet summary (CNYm) Intangible fixed assets 20,993 21,361 21,361 21,361 Tangible fixed assets 12,737 17,537 23,353 29,297 Current assets 65,841 95,208 121,865 163,189 Cash & others 13,853 30,297 53,749 91,359 Total assets 99,571 134,106 166,579 213,848 Operating liabilities 19,388 25,936 37,983 56,622 Gross debt 25,677 35,879 35,879 35,879 Net debt 11,824 5,582-17,869-55,480 Shareholders funds 53,420 70,620 91,045 119,675 Invested capital 66,330 77,873 74,847 65,867 Valuation data Year to 12/2014a 12/2015e 12/2016e 12/2017e EV/sales 7.1 5.1 3.7 2.6 EV/EBITDA 20.9 21.8 15.6 10.1 EV/IC 5.3 4.4 4.3 4.3 PE* 30.6 32.0 21.9 15.6 P/Book value 8.1 6.1 4.7 3.6 FCF yield (%) 4.2 4.9 6.8 11.0 Dividend yield (%) 0.0 0.0 0.0 0.0 Note: * = Based on HSBC EPS (fully diluted) Price relative 254 204 154 104 54 54 2013 2014 2015 2016 BAIDU.COM INC. Rel to NASDAQ 100 INDEX Note: price at close of 27 Jul 2015 254 204 154 104 Ratio, growth and per share analysis Year to 12/2014a 12/2015e 12/2016e 12/2017e Y-o-y % change Revenue 53.6 36.7 30.2 26.9 EBITDA 21.3-6.0 30.3 36.3 Operating profit 14.4-13.2 41.2 39.8 PBT 18.8-6.7 49.7 46.0 HSBC EPS 27.7-4.3 45.8 40.1 Ratios (%) Revenue/IC (x) 0.9 0.9 1.1 1.6 ROIC 21.8 14.7 19.1 28.3 ROE 28.7 19.7 22.7 25.0 ROA 14.4 9.3 11.4 13.2 EBITDA margin 34.2 23.5 23.5 25.3 Operating profit margin 26.1 16.6 18.0 19.8 EBITDA/net interest (x) Net debt/equity 21.7 7.7-19.3-45.7 Net debt/ebitda (x) 0.7 0.4-0.9-2.0 CF from operations/net debt 151.7 370.0 Per share data (CNY) EPS reported (fully diluted) 40.12 38.41 56.01 78.48 HSBC EPS (fully diluted) 40.12 38.41 56.01 78.48 DPS 0.00 0.00 0.00 0.00 Book value 152.22 200.96 259.08 340.55 2
2Q15 Baidu earnings snapshot RMB 000 except EPS in USD 2Q15 Delta 3Q15 Actual HSBC Consensus Vs HSBC Vs Consensus Guidance HSBC Consensus Total revenues 16,575,238 16,638,208 16,585,474-0.4% -0.1% 18,375,000 18,674,466 18,790,733 memo: QoQ growth 30.3% 30.8% 30.3% 10.9% 12.2% memo: YoY growth 38.3% 38.8% 38.4% 35.9% 38.1% 39.0% Cost of revenues (6,503,020) (6,562,298) -0.9% Business tax and surcharges (1,175,617) (1,231,227) -4.5% Traffic acquisition costs (2,111,734) (2,329,349) -9.3% Bandwidth costs (896,156) (871,842) 2.8% Depreciation of servers and other equipment (616,072) (634,431) -2.9% Operational costs (850,503) (745,065) 14.2% Content Costs (840,223) (740,400) 13.5% Share-based comp expenses (12,715) (9,983) Gross profits 10,072,218 10,075,910 10,024,592 0.0% 0.5% memo: GM 60.8% 60.6% 60.4% SGA (3,889,844) (3,867,973) 0.6% Research and development (2,712,681) (2,129,691) 27.4% Total operating costs and expenses (13,105,545) (12,559,962) 4.3% memo: QoQ growth 24.0% 18.8% memo: YoY growth 55.5% 49.0% Operating profit 3,469,693 4,078,246 3,921,615-14.9% -11.5% memo: OM 20.9% 24.5% 23.6% Adjusted EPS USD 1.80 USD 1.98 USD 1.88-9.0% -4.0% Source: Company data, Bloomberg, HSBC estimates HSBC estimates changes RMB m except EPS in USD 3Q15 4Q15 2015e 2016e 2017e Current Revenue 18,454 19,289 67,043 87,314 110,802 GM 60.8% 60.5% 60.2% 59.9% 59.6% OM 18.2% 11.0% 16.6% 18.0% 19.8% Non-GAAP EPS $1.76 $1.34 $6.20 $9.03 $12.66 Previous Revenue 18,674 19,482 67,519 88,964 108,076 GM 61.1% 60.7% 60.3% 60.1% 59.5% OM 28.4% 25.0% 24.3% 26.5% 26.6% Non-GAAP EPS $2.47 $2.37 $8.08 $12.36 $15.85 Delta Revenue -1% -1% -1% -2% 3% GM bps (29) (21) (9) (19) 12 OM bps (1,013) (1,404) (773) (850) (683) Non-GAAP EPS -29% -43% -23% -27% -20% estimates Estimate changes. We slightly lower our revenue estimate by 1%/2% for 2015 and 2016 to reflect slightly softer revenue guidance. We also reduce margins to reflect stepped-up spending on O2O. We now expect operating margins of 16.6%/18.0% in 2015e/2016e, compared to 24.3%/26.5% previously. Accordingly, we lower our non-gaap EPS estimate by 23%/27% for 2015e/2016e, respectively. Valuation: We continue to value Baidu using a PEG approach. To derive our new target price, we apply our estimated 2015-18 non-gaap EPS CAGR of 40% (previously 35%) to our 2015e EPS of USD6.40 and an unchanged PEG target of 0.90. The yields a fair value TP of USD231. Key downside risks including slower speed of monetization, lower margins, increasing competition and regulation. 3
Disclosure appendix Analyst Certification The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Chi Tsang and Alice Cai Important disclosures Equities: Stock ratings and basis for financial analysis HSBC believes an investor's decision to buy or sell a stock should depend on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations and that investors utilise various disciplines and investment horizons when making investment decisions. Ratings should not be used or relied on in isolation as investment advice. Different securities firms use a variety of ratings terms as well as different rating systems to describe their recommendations and therefore investors should carefully read the definitions of the ratings used in each research report. Further, investors should carefully read the entire research report and not infer its contents from the rating because research reports contain more complete information concerning the analysts' views and the basis for the rating. From 23rd March 2015 HSBC has assigned ratings on the following basis: The target price is based on the analyst s assessment of the stock s actual current value, although we expect it to take six to 12 months for the market price to reflect this. When the target price is more than 20% above the current share price, the stock will be classified as a Buy; when it is between 5% and 20% above the current share price, the stock may be classified as a Buy or a Hold; when it is between 5% below and 5% above the current share price, the stock will be classified as a Hold; when it is between 5% and 20% below the current share price, the stock may be classified as a Hold or a Reduce; and when it is more than 20% below the current share price, the stock will be classified as a Reduce. Our ratings are re-calibrated against these bands at the time of any 'material change' (initiation or resumption of coverage, change in target price or estimates). Upside/Downside is the percentage difference between the target price and the share price. Prior to this date, HSBC s rating structure was applied on the following basis: For each stock we set a required rate of return calculated from the cost of equity for that stock s domestic or, as appropriate, regional market established by our strategy team. The target price for a stock represented the value the analyst expected the stock to reach over our performance horizon. The performance horizon was 12 months. For a stock to be classified as Overweight, the potential return, which equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated, had to exceed the required return by at least 5 percentage points over the succeeding 12 months (or 10 percentage points for a stock classified as Volatile*). For a stock to be classified as Underweight, the stock was expected to underperform its required return by at least 5 percentage points over the succeeding 12 months (or 10 percentage points for a stock classified as Volatile*). Stocks between these bands were classified as Neutral. *A stock was classified as volatile if its historical volatility had exceeded 40%, if the stock had been listed for less than 12 months (unless it was in an industry or sector where volatility is low) or if the analyst expected significant volatility. However, stocks which we did not consider volatile may in fact also have behaved in such a way. Historical volatility was defined as the past month's average of the daily 365-day moving average volatilities. In order to avoid misleadingly frequent changes in rating, however, volatility had to move 2.5 percentage points past the 40% benchmark in either direction for a stock's status to change. 4
Rating distribution for long-term investment opportunities As of, the distribution of all ratings published is as follows: Buy 42% (30% of these provided with Investment Banking Services) Hold 42% (28% of these provided with Investment Banking Services) Sell 16% (18% of these provided with Investment Banking Services) For the purposes of the distribution above the following mapping structure is used during the transition from the previous to current rating models: under our previous model, Overweight = Buy, Neutral = Hold and Underweight = Sell; under our current model Buy = Buy, Hold = Hold and Reduce = Sell. For rating definitions under both models, please see Stock ratings and basis for financial analysis above. Share price and rating changes for long-term investment opportunities BAIDU.COM INC. (BIDU.OQ) Share Price performance USD Vs HSBC rating history 260 210 160 110 60 10 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Recommendation & price target history From To Date Overweight Overweight (V) 08 August 2012 Overweight (V) Overweight 07 May 2013 Overweight Buy 26 March 2015 Target Price Value Date Price 1 157.00 08 August 2012 Price 2 140.00 30 October 2012 Price 3 133.00 28 January 2013 Price 4 131.00 05 February 2013 Price 5 128.00 26 April 2013 Price 6 166.00 31 July 2013 Price 7 200.00 30 October 2013 Price 8 218.00 24 February 2014 Price 9 210.00 27 February 2014 Price 10 218.00 25 April 2014 Price 11 245.00 25 July 2014 Price 12 275.00 30 October 2014 Price 13 250.00 12 February 2015 Price 14 256.00 30 April 2015 5
HSBC & Analyst disclosures Disclosure checklist Company Ticker Recent price Price Date Disclosure BAIDU.COM INC. BIDU.OQ 197.68 27-Jul-2015 6 1 HSBC has managed or co-managed a public offering of securities for this company within the past 12 months. 2 HSBC expects to receive or intends to seek compensation for investment banking services from this company in the next 3 months. 3 At the time of publication of this report, HSBC Securities (USA) Inc. is a Market Maker in securities issued by this company. 4 As of 30 June 2015 HSBC beneficially owned 1% or more of a class of common equity securities of this company. 5 As of 31 May 2015, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of investment banking services. 6 As of 31 May 2015, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of non-investment banking securities-related services. 7 As of 31 May 2015, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of non-securities services. 8 A covering analyst/s has received compensation from this company in the past 12 months. 9 A covering analyst/s or a member of his/her household has a financial interest in the securities of this company, as detailed below. 10 A covering analyst/s or a member of his/her household is an officer, director or supervisory board member of this company, as detailed below. 11 At the time of publication of this report, HSBC is a non-us Market Maker in securities issued by this company and/or in securities in respect of this company HSBC and its affiliates will from time to time sell to and buy from customers the securities/instruments (including derivatives) of companies covered in HSBC Research on a principal or agency basis. Analysts, economists, and strategists are paid in part by reference to the profitability of HSBC which includes investment banking revenues. Whether, or in what time frame, an update of this analysis will be published is not determined in advance. For disclosures in respect of any company mentioned in this report, please see the most recently published report on that company available at www.hsbcnet.com/research. Additional disclosures 1 This report is dated as at. 2 All market data included in this report are dated as at close 27 July 2015, unless otherwise indicated in the report. 3 HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its Research business. HSBC's analysts and its other staff who are involved in the preparation and dissemination of Research operate and have a management reporting line independent of HSBC's Investment Banking business. Information Barrier procedures are in place between the Investment Banking and Research businesses to ensure that any confidential and/or price sensitive information is handled in an appropriate manner. 6
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